Written evidence submitted by MSV Housing [FSS 005]

The sector is under ever-increasing financial pressures. It remains resilient, and immediate financial viability isn’t the primary concern – rather it’s the ever-increasing expectations placed on the sector, alongside limited options for increasing capacity and resourcing. Things are being spread too thinly, which impacts the quality of homes and services. Due to repeated restraining of income streams and rising costs, the sector is reaching a ‘crunch point’ at which it will no longer be financially viable.

Social housing providers have evolved from being landlords to those on low incomes, to supporting complex households. HAs are often the ‘last man standing’ in the wake of reductions and withdrawals in other public service provision. increasingly, we are finding that a growing proportion of residents in general needs housing also have more complex needs, but without the support they require. This is further exacerbated by a chronic under-supply of housing, including social housing, over many years and as social housing is typically allocated on a needs-basis, those who now reach the top of the allocations list typically have other issues other than just a need for housing.

The sector has demonstrated its financial resilience in light of challenges. However it is becoming increasingly challenging to make long-term financial investment plans against a backdrop of short-term income certainty and, in recent years, uncertainty. Decisions to invest are made on an assumption of rental increases keeping pace with inflation, albeit with certainty typically provided in 4–5-year blocks. However, over the last decade this certainty has wavered, with the reversal of Rent Policy and rent decrease, and more recently the capping of social rent increases at sub-inflationary levels.

In addition to being good landlords, HAs have also evolved to become at-scale house builders. Unlike commercial builders, HAs do not develop solely for profit; and as such juggle the needs of affordability of build vs affordability of tenure, often seeking to subsidise through home ownership offers. Historically Government grant was provided to bridge the gap, but the levels of grant funding have not kept pace with build cost inflation. The LHA cap has also failed to keep pace with inflation and, whilst this does not apply to social housing as such, many Local Authorities require social housing rents to be capped at these levels on new build homes. The combination of suppressed rents, reduced grants and inflationary increases on build costs make it extremely difficult to develop new affordable housing, particularly in low value areas such as the NW England.

An emerging threat to future financial resilience is the impact of all of the above on the perception of the funding markets and credit rating agencies on the sector. Previously social housing providers were viewed as a stable; counter-cyclical, ‘safe’ bet when it came to financial investment. However, the repeated interruptions mean the sector is viewed as not as safe as it used to be.

Inflation has placed a high pressure on social housing providers. Development has been reduced in order to manage expenditure levels – in many cases the same amount is being spent, but due to inflation is delivering less. If the Government required HAs to continue to play a significant role in tackling the housing crisis through building of new homes, the investment and subsidy model needs to be revisited.

Generally, utilities costs to residential homes are borne by customers, either directly or through service charges. The impact of direct utilities costs to the business is, by comparison, manageable. The challenge is balancing affordability and subsidy with the need to cover costs. We’ve met this challenge by passing on costs in full, but then by setting aside significant hardship support that can be targeted to customers who are struggling. The increased energy costs are impacting in terms of the cost-of-living difficulties facing many social housing tenants, with the impact on HAs being their attempts to alleviate some of these pressures and provide financial and other support to enable customers to maintain their tenancies and sustain an acceptable standard of living.

Routine maintenance is another challenge, where the combination of high inflation on materials and third-party labour, supply chain issues (due to Brexit?) and a competitive and now under-supplied employment market (due to Brexit and labour migration) have all combined to make it difficult to meet day-to-day maintenance obligations. In ‘normal’ circumstances this would be manageable, but the rent cap has meant that income has not kept pace with the growing running costs, and so it has been necessary to curtail activity elsewhere – such as reducing development activity. It is hoped that this is a short-term challenge of 1-2 years rather than a longer-term challenge.

Fire safety and damp and mould remediation costs have featured heavily in the media recently. However, these are a symptom, not a cause, of financial pressures and a systemic underinvestment in the social housing infrastructure. Social housing stock is some of the oldest, most difficult to treat, housing and has suffered from significant under-investment from Government over many years. HAs have invested £billions in maintaining such stock, which is becoming increasingly difficult. In the NW, a significant proportion of social homes are pre-1919 terraced housing of single wall construction. Maintaining these old homes, and now with the added expectation of decarbonisation, means that much of the UK’s social housing portfolio is uneconomical to invest in. There is a need for Government to recognise this and provide appropriate, sustained subsidy.

Overall current spend pressures would not be sustainable indefinitely without significant detrimental impact to service delivery and/or curtailment of development activity, but in the short-term this can be managed.

Historically the sector has been referred to as counter-cyclical, however this is no longer really the case. The counter-cyclical nature of social housing providers arose from the inflation-linked rental income formula – so in times when inflation is high, and therefore many commercial developers withdraw due to rising costs, the social housing sector could continue to invest on the basis of its primary income stream keeping pace with inflation, thereby maintaining overall capacity.

Recently this certainty has been removed with a 4/5 year rent settlement that can easily be reversed mid-settlement. During times of low inflation, social housing providers’ revenue streams are low; however now, during times of high inflation revenue streams are also curtailed at sub-inflationary levels, therefore reducing capacity.

Under the CPI+1% formula, the +1% element has typically been directed to new development; a future settlement of CPI+1%, with added guarantees that this will not change, would help provide the certainty needed that ongoing investment in developing new homes is sustainable. However, sector confidence in such promises has been eroded.

Social housing development is not viable at the scale required, especially in areas where property values and market rents are relatively low. Such development is typically subsidised through non-social development tenures, and with reliance on Government grant to bridge the gap. However, government grant levels have not grown in line with build cost inflation, and as such the subsidy gap has widened, requiring more subsidy funded by HAs. With development cost inflation at high levels and the threat of a potential housing market downturn, this increases the risk HAs would need to take in order to subsidise social development. Given the overriding priority to protect the existing social housing stock, the consequence of these factors is that many HAs are reducing the scale of development.

Another pressure in terms of housing development is competing priority. Recently there have been spotlights shined on the sector in terms of fire safety and property condition. However, these issues require significant investment to remediate, and were not previously factored into Business Plans. They are symptomatic of the age and archetype of an ever-ageing social housing portfolio, combined with decades of lack of Government investment in regeneration. The decarbonisation agenda is now placing enormous financial pressures on the sector. These mandated EPC requirements, which do not apply to private rental or home ownership sectors, place an additional expenditure burden of millions on social housing providers. Whilst there is some government funding available to support this, this is short-term and insufficient to meet the investment obligations being placed on social housing providers. In terms of priorities, more and more social housing providers are cutting back on new development in order to afford investment in existing homes and maintain service levels in an increasingly complex environment.

Changes in the housing market have not had a huge positive impact on social housing balance sheets as, in the main, housing assets are held at construction cost not market value. Unless properties are held for financial gain, such as market rental properties, growth in housing market values do not directly translate into Balance Sheet growth, as social housing assets are not held at market value and are, operationally, only worth the value of the net income they can generate – which in recent years has failed to meet projected expectations due to rent cuts, rent capping and high inflation.

Growth in housing market values does, in some cases, create additional Balance Sheet capacity in terms of the leverage they provide as new debt can be secured on existing homes. However, the majority of social housing lenders require property security to be valued at either Existing Use Value or Market Value Subject to Tenancy, both of which are lower than market values, with the former detrimentally impacted by growing costs and capped rents. Most funders will only accept a small proportion of security portfolios that are not social rent which limits the ability to leverage funding in an environment where social rent development becomes unviable.

The increasing cost of development and threat of housing price reductions makes this a higher risk more recently, with lower margins due to increasing costs. There is a question as whether this method of cross-subsidy, as opposed to a more sufficient grant subsidy model, places social housing assets at unnecessary risk.

If Government seeks to sustain social housing development at scale, but without placing existing social housing assets at risk, then the requirement is for Government subsidy in the form of grants targeted at those tenures which are currently unaffordable, and which maintains growth at a pace to match build cost inflation.

The main challenge is of equity – new entrants with significant start-up investment capital do not have to grapple with the challenges of most social housing providers. Managing a portfolio of custom-built, eco-friendly new builds is more straightforward and less cost intensive from an asset management perspective than managing an ageing portfolio. New entrants also have the advantage of starting from scratch regarding technology and systems. It is also questionable whether new entrants have the same commitment to social purpose above profit as the majority of the existing social housing providers.

Typically, within the sector salaries are not over-generous and the pressures on resources are increasing. With the new customer regulation, the increasing complexity of the typical social rent household, and the withdrawal of other health and social care services, it is difficult to identify where activities could be scaled back. Typically, the potential to scale back-office departments has already been done.

Development activity can arguably be curtailed, but with much of the sector reliant on bank-based debt with EBITDA-MRI covenants, this does not provide additional headroom against bank constraints. This is also finite – investment in development creates new properties, which can be used to secure new debt, which can be used to build more properties, and so on. If borrowing capacity is utilised predominantly to invest in existing homes, this does not create new homes to be used as security, and the security value of the homes receiving the investment do not increase and so cannot be used to leverage new funding, as they are typically based on future net rental income. So eventually if investment capacity is directed solely or predominantly to existing homes, capacity will be fully utilised and the sector will stagnate, with no capacity for further growth or diversification.

This is a particular challenge in the NW, with older, pre-war terraced housing which is difficult to maintain and decarbonise, compounded by low property values. It is difficult to see how a model requiring more investment into such homes would not create an unmanageable financial burden on HAs. Such homes do, however, provide at-scale density of communities which could not easily be replaced, and are therefore a socially, if not financially, valuable component of the social housing portfolio. In order to invest in such homes and geographies, regeneration funding and subsidy for non-viable investment is required. These pressures are driving many HAs to consider the difficult decisions around disposal strategies, at market values which do not support 1-for-1 replacement.

This is a decision taken by the Board and is a balance between investment in new vs existing homes, and also in property vs service expenditure. Other financial pressures, with the increasing difficulties in making social and affordable development ‘stack up’, means that the scale of development programmes are being reduced in order to prioritise existing homes and services.

For all Boards health & safety of tenants is a non-negotiable priority. The growing pressures on safety spend are symptomatic of under-investment in regeneration, further exacerbated by growing cost inflation that has outstripped income growth due to Government decisions to impose rent reductions and cap increases at sub-inflationary levels.

For the vast majority of Boards, investment in ensuring safety is not a compromise. As such, other investment will be cut in favour of maintaining safety standards.

Q11

The emergence of for-profit housing providers has not made the sector more financially robust. These may present some commercial opportunities at a local, organisation-specific level; however, they do nothing to address the fundamental and systemic issues inherent in the sector, the shortfalls of historic Government investment, or the challenges inherent in the existing social housing property portfolio.

Q12

There comes a point when a large organisation, particularly with a spread geographic footprint, can no longer be expected to maintain a local presence and knowledge. This depends on what is seen as the role and priority of social housing.

From a financial viability perspective, this remains a feasible option at present – a larger organisation will typically have more financial resilience and more levers it can pull in difficult times. However, the current pressures on the sector are being faced by all, regardless of scale. As all are facing such pressures, it makes the attractiveness of such a takeover less, and there is a realistic chance that, in a serious case of failure, there may not be an organisation willing to step in and ‘rescue’ a failing HA.

A further risk that arises from historic merger activity is the question of “are some HAs too big to fail”. Should one of these fall into difficulties, it is difficult to envisage which organisation(s) would be willing to step in and take on such a significant burden.

Q13
This can depend on the LA but generally partnership working can unlock opportunities that would otherwise not be achievable.

However, whilst such partnership working creates a positive impact and new opportunity we do not believe that it increases the resilience of the sector per se.

Q14

This tenure offers an opportunity for those customers who cannot afford full home ownership but aspire to this. The positives of this tenure are that it can offer all the benefits, security and sense of responsibility of home ownership, but in a more affordable way.

However, in recent years this has been diluted and making this an unviable development option in such areas of NW. In addition, the obligations for maintenance which now also have been passed to HAs in the first 10 years make this even less financially viable. If the Government were to proceed with proposals to allow 1% staircasing we believe this would be both financially unviable for the buyer, and for the sector would effectively kill-off any future desires to develop this tenure.

Recently, as living costs and interest rates have risen, this has proven to be a precarious tenure as many shared owners’ financial circumstances sit on the cusp of affordability.

It would be preferable for a higher proportion of the AHP to be directed to social and affordable rented homes, for which there is a significant unmet need and a requirement for additional subsidy.

Q16

It is likely that this will reduce the number of affordable homes created. S106 forms a significant element of some HAs’ development programmes and is beneficial to both commercial developers and HAs. This should be reversed if Government wishes to preserve balanced development, avoid unnecessary reduction in scale of development, and creation of mixed communities into the future.

Q17

This is skewed towards home ownership, with social and affordable rent still portrayed as a tenure of last resort. Policies on Right to Buy / Right to Acquire have decimated the numbers of social homes available, with many acquired under these regimes ending up in the private rented sector.

Q20

No, due to the issue being threefold:

- There is no grant available for regeneration and remodelling of existing homes. In the NW this is an issue due to archetype and age profile of the social housing stock.

- Grant subsidy has failed to keep pace with build cost growth, making it increasingly difficult to achieve financial viability on schemes, particularly social and affordable rent, or where land must be acquired in order to develop.

- There needs to be a rebalancing of where grant is targeted, with more directed to social and affordable rent development at scale to meet the unmet demand for this type of housing.

Q22

This is the responsibility of, and decision for Boards. The RSH maintains oversight and will typically conduct an IDA within 12 months of a merger, thereby providing the necessary assurances (or otherwise) that the new entity meets the required standards.

From a financial viability perspective, there exist other compensatory measures. Practically all HAs have at least some element of banking or private investment debt within their funding portfolio, which almost certainly includes consent clauses around mergers of scale. Funders and investors closely scrutinise the financial forecasts associated with mergers to ensure the new organisation remains financially viable.

Q23

It is for HA Boards to decide the appropriate balance of risk across the organisation. RSH’s role is to ensure there has been appropriate governance and the RSH does have sufficient scrutiny in this.

What is meant by VfM will differ in every organisation. The VfM Standard sets out high-level expectations, however the Metrics are focussed on financial value and return on investment, and don’t consider the social value generation from investment. The introduction of TSMs and Consumer Regulation, if considered alongside the VfM Metrics, will provide a better insight into value.

Q24

The current fee structure reflects the size (in terms of units), but not the overall scale of activity or complexity. As such, larger ‘vanilla’ HAs will be charged more for regulation than a smaller, complex Group with multiple diverse activity streams. It would be reasonable for this to be reconsidered.

There is little recourse for the sector in terms of who pays for the RSH to hold them to account, no performance measures and no clear mechanisms for complaint and challenge. It would seem reasonable that the RSH should also be held to the same rigorous expectations around value, service delivery, performance and governance.

Q26

Yes, in the short-term, and likely in the longer-term without reform. For all the reasons given above, the capacity and appetite for development is reducing.

May 2023